I don’t really know where to put this, so I decided here since it has some tax implications. And it is just something of curiosity on my part, I just don’t understand why this works.
I read an article online that said rich people can indefinitely borrow money against their holdings so they don’t sell them. Especially really rich people like billionaires. I read once Zuckerberg does this.
My question is, how is it better to take on debt instead of just selling some stock? It was said that if the appreciation of the stock rises faster than the interest rate, then it allows them to avoid capital gain taxes. But the loans eventually have to be paid back…why would someone be able to avoid cap taxes indefinitely? In fact the article mentioned this as a buy-borrow-die strategy. How is that, may I ask? Thanks…
Tax law steps up the cost basis of the deceased’s assets to current market value at date of death. So the stocks can be sold tax free at that point, and the old loans repaid. If the stock has appreciated faster than the interest accrued/paid, the estate comes out ahead financially. The deceased remains deceased, however, so hard to call it a win.
Depending on your income level and state/local taxes, selling stock may incur huge taxes. The top federal tax rate on long-term capital gains is 20%, plus a 3.8% net investment income tax. Add a 13.3% California state tax, and you’re looking at a roughly 37% tax rate.
On top of that, much of the wealth of tech billionaires comes in the form of stock in companies they founded or were early employees in, where their basis price is likely really close to $0.
Put those factors together, and many of them may be in a spot where to raise $1,000,000 of personal cash, they would need to sell nearly $1,600,000 of stock to do so. Contrast that with a portfolio margin loan at 6% where that $1,000,000 might cost them $5,000 per month ($60,000 per year) in interest.
There’s also the optics involved… Many of those folks have to publicly report when they sell stock in their companies. So it doesn’t give a good “look of confidence in the business” if they’re frequently selling a bit, even if it’s just because they have bills to pay, too.
Another thing they have to factor in is the fact that when they sell some of their shares, they give up a portion of their control over the company. Do that enough, and it becomes easier for them to get ousted.
Net — a strategy like that might make sense for them for reasons that don’t apply nearly as much to us mere mortals…
Thank you for the reply. I would agree, that is hard to call a win. I would assume most try to get up to that basis before the end. Be interesting to know how many wealthy individuals actually use this strategy.
The optics thing I can see, but I’m betting that may not be so bad if a stock is rising rapidly (as in the case of PLTR and Karp’s sales; and I assume he has to pay taxes on that, but since the stock hasn’t become more stable yet like META, I can see this strategy)
The control thing…ah, that strikes a big chord of logic with me. Never thought of that. That would be very incentivizing for the strategy.
And the $5,000 per month thing…yeah, that does make sense too.
I guess the last-mile consideration of investing is the tax situation, that is the final arbiter of return. Very complex. Thanks for explaining this to me.
Yes, I can see this as well. I guess families that have this in place use this strategy too. As I said in another reply, I would love to read a paper that summarizes how commonplace this strategy is for individuals and family trusts. Thank you…
The whole thing makes little sense as stated. Someone is willing to pay interest of 6% a year to access money rather than pay a one time 23.8% tax? After 4 years, you’ve already paid more interest than the tax would have cost you. It’s a similar argument to “paying mortgage interest for the deduction”, both fallacious arguments. Even with high state taxes, after 5 or 5 1/2 years, you’d pay more interest than tax. So quite obviously this isn’t the reason.
More likely the reasons are a combination of:
You want to retain ownership of the shares to maintain control. If you own only 51% of your company, you’re loath to sell any of them lest you eventually lose control to someone else who somehow gets control (or agreements) of 50+% of it.
You think the value of the equity will rise much faster than the interest you are paying, so it is worth paying the 6% interest while the shares are growing at 10+%.
You are getting on in years and you think that you may die before ending this trade. That will allow a step up in basis for your heirs on that equity.
So, nobody is rally doing this to “avoid current taxes”, it’s much more of an ownership strategy, and an overall estate plannign strategy that eventually reduces the total taxes that will become due. But all estate plans have some aspect of avoiding unnecessary taxes.